Derivatives Workbook E-Book
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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: The CFA Institute Series
- Sprache: Englisch
Hands-on practice with derivatives and derivative markets based on real-world scenarios Derivatives Workbook provides the key component of effective learning--practice. Designed for both students and investment professionals, this companion workbook conveniently aligns with the Derivatives text chapter-by-chapter, offers brief chapter summaries to refresh your memory on key points before you begin working, and explicitly lays out the learning objectives so you understand the "why" of each problem. This workbook helps you: * Synthesize essential material from the Derivatives text using real-world applications * Understand the different types of derivatives and their characteristics * Delve into the various markets and their associated contracts * Examine the role of derivatives in portfolio management * Learn why derivatives are increasingly fundamental to risk management CFA Institute is the world's premier association for investment professionals, and the governing body for CFA¯® Program, CIPM¯® Program, CFA Institute ESG Investing Certificate, and Investment Foundations¯® Program. Those seeking a deeper understanding of the markets, mechanisms, and use of derivatives will value the level of expertise CFA Institute brings to the discussion as well as the extra practice delivered in Derivatives Workbook based on real scenarios investors face every day.
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Veröffentlichungsjahr: 2021
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CFA Institute is the premier association for investment professionals around the world, with over 170,000 members in more than 160 countries. Since 1963 the organization has developed and administered the renowned Chartered Financial Analyst® Program. With a rich history of leading the investment profession, CFA Institute has set the highest standards in ethics, education, and professional excellence within the global investment community, and is the foremost authority on investment profession conduct and practice. Each book in the CFA Institute Investment Series is geared toward industry practitioners along with graduate-level finance students and covers the most important topics in the industry. The authors of these cutting-edge books are themselves industry professionals and academics and bring their wealth of knowledge and expertise to this series.
DERIVATIVES WORKBOOK
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ISBN 9781119853282 (ePDF)
ISBN 9781119853299 (ePub)
CONTENTS
PART I LEARNING OBJECTIVES, SUMMARY OVERVIEW, AND PROBLEMS
CHAPTER 1 DERIVATIVE MARKETS AND INSTRUMENTS
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 2 BASICS OF DERIVATIVE PRICING AND VALUATION
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 3 PRICING AND VALUATION OF FORWARD COMMITMENTS
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 4 VALUATION OF CONTINGENT CLAIMS
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 5 CREDIT DEFAULT SWAPS
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 6 INTRODUCTION TO COMMODITIES AND COMMODITY DERIVATIVES
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 7 CURRENCY MANAGEMENT: AN INTRODUCTION
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 8 OPTIONS STRATEGIES
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 9 SWAPS, FORWARDS, AND FUTURES STRATEGIES
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 10 INTRODUCTION TO RISK MANAGEMENT
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 11 MEASURING AND MANAGING MARKET RISK
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 12 RISK MANAGEMENT FOR INDIVIDUALS
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 13 CASE STUDY IN RISK MANAGEMENT: PRIVATE WEALTH
LEARNING OUTCOMES
SUMMARY OVERVIEW
PROBLEMS
CHAPTER 14 INTEGRATED CASES IN RISK MANAGEMENT: INSTITUTIONAL
LEARNING OUTCOMES
PART II SOLUTIONS
CHAPTER 1 DERIVATIVE MARKETS AND INSTRUMENTS
SOLUTIONS
CHAPTER 2 BASICS OF DERIVATIVE PRICING AND VALUATION
SOLUTIONS
CHAPTER 3 PRICING AND VALUATION OF FORWARD COMMITMENTS
SOLUTIONS
CHAPTER 4 VALUATION OF CONTINGENT CLAIMS
SOLUTIONS
CHAPTER 5 CREDIT DEFAULT SWAPS
SOLUTIONS
CHAPTER 6 INTRODUCTION TO COMMODITIES AND COMMODITY DERIVATIVES
SOLUTIONS
CHAPTER 7 CURRENCY MANAGEMENT: AN INTRODUCTION
SOLUTIONS
CHAPTER 8 OPTIONS STRATEGIES
SOLUTIONS
CHAPTER 9 SWAPS, FORWARDS, AND FUTURES STRATEGIES
SOLUTIONS
CHAPTER 10 INTRODUCTION TO RISK MANAGEMENT
SOLUTIONS
CHAPTER 11 MEASURING AND MANAGING MARKET RISK
SOLUTIONS
CHAPTER 12 RISK MANAGEMENT FOR INDIVIDUALS
SOLUTIONS
CHAPTER 13 CASE STUDY IN RISK MANAGEMENT: PRIVATE WEALTH
SOLUTIONS
END USER LICENSE AGREEMENT
Guide
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PART I
LEARNING OBJECTIVES, SUMMARY OVERVIEW, AND PROBLEMS
CHAPTER 1DERIVATIVE MARKETS AND INSTRUMENTS
LEARNING OUTCOMES
The candidate should be able to:
define a derivative and distinguish between exchange-traded and over-the-counter derivatives;
contrast forward commitments with contingent claims;
define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives and compare their basic characteristics;
determine the value at expiration and profit from a long or a short position in a call or put option;
describe purposes of, and controversies related to, derivative markets;
explain arbitrage and the role it plays in determining prices and promoting market efficiency.
SUMMARY OVERVIEW
This first reading on derivatives introduces you to the basic characteristics of derivatives, including the following points:
A derivative is a financial instrument that derives its performance from the performance of an underlying asset.
The underlying asset, called the underlying, trades in the cash or spot markets and its price is called the cash or spot price.
Derivatives consist of two general classes: forward commitments and contingent claims.
Derivatives can be created as standardized instruments on derivatives exchanges or as customized instruments in the over-the-counter market.
Exchange-traded derivatives are standardized, highly regulated, and transparent transactions that are guaranteed against default through the clearinghouse of the derivatives exchange.
Over-the-counter derivatives are customized, flexible, and more private and less regulated than exchange-traded derivatives, but are subject to a greater risk of default.
A forward contract is an over-the-counter derivative contract in which two parties agree that one party, the buyer, will purchase an underlying asset from the other party, the seller, at a later date and at a fixed price they agree upon when the contract is signed.
A futures contract is similar to a forward contract but is a standardized derivative contract created and traded on a futures exchange. In the contract, two parties agree that one party, the buyer, will purchase an underlying asset from the other party, the seller, at a later date and at a price agreed on by the two parties when the contract is initiated. In addition, there is a daily settling of gains and losses and a credit guarantee by the futures exchange through its clearinghouse.
A swap is an over-the-counter derivative contract in which two parties agree to exchange a series of cash flows whereby one party pays a variable series that will be determined by an underlying asset or rate and the other party pays either a variable series determined by a different underlying asset or rate or a fixed series.
An option is a derivative contract in which one party, the buyer, pays a sum of money to the other party, the seller or writer, and receives the right to either buy or sell an underlying asset at a fixed price either on a specific expiration date or at any time prior to the expiration date.
A call is an option that provides the right to buy the underlying.
A put is an option that provides the right to sell the underlying.
Credit derivatives are a class of derivative contracts between two parties, the credit protection buyer and the credit protection seller, in which the latter provides protection to the former against a specific credit loss.
A credit default swap is the most widely used credit derivative. It is a derivative contract between two parties, a credit protection buyer and a credit protection seller, in which the buyer makes a series of payments to the seller and receives a promise of compensation for credit losses resulting from the default of a third party.
An asset-backed security is a derivative contract in which a portfolio of debt instruments is assembled and claims are issued on the portfolio in the form of tranches, which have different priorities of claims on the payments made by the debt securities such that prepayments or credit losses are allocated to the most-junior tranches first and the most-senior tranches last.
Derivatives can be combined with other derivatives or underlying assets to form hybrids.
Derivatives are issued on equities, fixed-income securities, interest rates, currencies, commodities, credit, and a variety of such diverse underlyings as weather, electricity, and disaster claims.
Derivatives facilitate the transfer of risk, enable the creation of strategies and payoffs not otherwise possible with spot assets, provide information about the spot market, offer lower transaction costs, reduce the amount of capital required, are easier than the underlyings to go short, and improve the efficiency of spot markets.
Derivatives are sometimes criticized for being a form of legalized gambling and for leading to destabilizing speculation, although these points can generally be refuted.
Derivatives are typically priced by forming a hedge involving the underlying asset and a derivative such that the combination must pay the risk-free rate and do so for only one derivative price.
Derivatives pricing relies heavily on the principle of storage, meaning the ability to hold or store the underlying asset. Storage can incur costs but can also generate cash, such as dividends and interest.
Arbitrage is the condition that two equivalent assets or derivatives or combinations of assets and derivatives sell for different prices, leading to an opportunity to buy at the low price and sell at the high price, thereby earning a risk-free profit without committing any capital.
The combined actions of arbitrageurs bring about a convergence of prices. Hence, arbitrage leads to the law of one price: Transactions that produce equivalent results must sell for equivalent prices.
PROBLEMS
A derivative is
best
described as a financial instrument that derives its performance by:
passing through the returns of the underlying.
replicating the performance of the underlying.
transforming the performance of the underlying.
Derivatives are similar to insurance in that both:
have an indefinite life span.
allow for the transfer of risk from one party to another.
allow for the transformation of the underlying risk itself.
A beneficial opportunity created by the derivatives market is the ability to:
adjust risk exposures to desired levels.
generate returns proportional to movements in the underlying.
simultaneously take long positions in multiple highly liquid fixed-income securities.
Compared with exchange-traded derivatives, over-the-counter derivatives would
most likely
be described as:
standardized.
less transparent.
more transparent.
Exchange-traded derivatives are:
largely unregulated.
traded through an informal network.
guaranteed by a clearinghouse against default.
The clearing and settlement process of an exchange-traded derivatives market:
provides a credit guarantee.
provides transparency and flexibility.
takes longer than that of most securities exchanges.
Which of the following statements
best
portrays the full implementation of post-financial-crisis regulations in the OTC derivatives market?
Transactions are no longer private.
Most transactions need to be reported to regulators.
All transactions must be cleared through central clearing agencies.
A characteristic of forward commitments is that they:
provide linear payoffs.
do not depend on the outcome or payoff of an underlying asset.
provide one party the right to engage in future transactions on terms agreed on in advance.
In contrast to contingent claims, forward contracts:
have their prices chosen by the participants.
could end in default by either party.
can be exercised by physical or cash delivery.
Which of the following statements
best
describes the payoff from a forward contract?
The buyer has more to gain going long than the seller has to lose going short.
The buyer profits if the price of the underlying at expiration exceeds the forward price.
The gains from owning the underlying versus owning the forward contract are equivalent.
Which of the following statements regarding the settlement of forward contracts is correct?
Contract settlement by cash has different economic effects from those of a settlement by delivery.
Non-deliverable forwards and contracts for differences have distinct settlement procedures.
At cash settlement, when the long party acquires the asset in the market, it effectively pays the forward price.
A futures contract is
best
described as a contract that is:
standardized.
subject to credit risk.
marked to market throughout the trading day.
Which of the following statements explains a characteristic of futures price limits? Price limits:
help the clearinghouse manage its credit exposure.
can typically be expanded intra-day by willing traders.
establish a band around the final trade of the previous day.
Which of the following statements describes an aspect of margin accounts for futures?
The maintenance margin is always less than the initial margin.
The initial margin required is typically at least 10% of the futures price.
A margin call requires a deposit sufficient to raise the account balance to the maintenance margin.
Which of the following factors is shared by forwards and futures contracts?
Timing of profits
Flexible settlement arrangements
Nearly equivalent profits by expiration
Which of the following derivatives is classified as a contingent claim?
Futures contracts
Interest rate swaps
Credit default swaps
In contrast to contingent claims, forward commitments provide the:
right to buy or sell the underlying asset in the future.
obligation to buy or sell the underlying asset in the future.
promise to provide credit protection in the event of default.
Which of the following derivatives provide payoffs that are non-linearly related to the payoffs of the underlying?
Options
Forwards
Interest-rate swaps
An interest rate swap is a derivative contract in which:
two parties agree to exchange a series of cash flows.
the credit seller provides protection to the credit buyer.
the buyer has the right to purchase the underlying from the seller.
Forward commitments subject to default are:
forwards and futures.
futures and interest rate swaps.
interest rate swaps and forwards.
A swap is:
more like a forward than a futures contract.
subject to simultaneous default by both parties.
based on an exchange of two series of fixed cash flows.
A plain vanilla interest rate swap is also known as:
a basis swap.
a fixed-for-floating swap.
an overnight indexed swap.
The notional principal of a swap is:
not exchanged in the case of an interest rate swap.
a fixed amount whenever it is matched with a loan.
equal to the amount owed by one swap party to the other.
Which of the following derivatives is
least likely
to have a value of zero at initiation of the contract?
Futures
Options
Forwards
The buyer of an option has a contingent claim in the sense that the option creates:
a right.
an obligation.
a linear payoff with respect to gains and losses of the underlying.
Which of the following options grants the holder the right to purchase the underlying prior to expiration?
American-style put option
European-style call option
American-style call option
A credit derivative is a derivative contract in which the:
clearinghouse provides a credit guarantee to both the buyer and the seller.
seller provides protection to the buyer against the credit risk of a third party.
the buyer and seller provide a performance bond at initiation of the contract.
The junior and senior tranches of an asset-backed security:
have equivalent expected returns.
have claims on separate underlying portfolios.
may be differentially impacted by prepayments or credit losses.
In a declining interest rate environment, compared with a CMO’s Class A tranche, its Class C tranche will be repaid:
earlier.
at the same pace.
later.
For a given CDO, which of the following tranches is
most likely
to have the highest expected return?
Equity
Senior
Mezzanine
Which of the following derivatives allows an investor to pay the return on a stock index and receive a fixed rate?
Equity swap
Stock warrant
Index futures contract
Which of the following is
most likely
the underlying of a plain vanilla interest rate swap?
180-day Libor
10-year US Treasury bond
Bloomberg Barclay’s US Aggregate Bond Index
Currency swaps are:
rarely used.
commonly used to manage interest rate risk.
executed by two parties making a series of interest rate payments in the same currency.
Which of the following statements regarding commodity derivatives is correct?
The primary commodity derivatives are futures.
Commodities are subject to a set of well-defined risk factors.
Commodity traders and financial traders today are distinct groups within the financial world.
Compared with the underlying spot market, derivative markets are
more likely
to have:
greater liquidity.
higher transaction costs.
higher capital requirements.
Which of the following characteristics is
least likely
to be a benefit associated with using derivatives?
More effective management of risk
Payoffs similar to those associated with the underlying
Greater opportunities to go short compared with the spot market
Which of the following statements
best
represents information discovery in the futures market?
The futures price is predictive.
Information flows more slowly into the futures market than into the spot market.
The futures market reveals the price that the holder of the asset can take to avoid uncertainty.
The derivative markets tend to:
transfer liquidity from the broader financial markets.
not reflect fundamental value after it is restored in the underlying market.
offer a less costly way to exploit mispricing in comparison to other free and competitive financial markets.
Which of the following statements
most likely
contributes to the view that derivatives have some role in causing financial crashes?
Derivatives are the primary means by which leverage and related excessive risk is brought into financial markets.
Growth in the number of investors willing to speculate in derivatives markets leads to excessive speculative trading.
Restrictions on derivatives, such as enhanced collateral requirements and credit mitigation measures, in the years leading up to crashes introduce market rigidity.
In contrast to gambling, derivatives speculation:
has a positive public image.
is a form of financial risk taking.
benefits the financial markets and thus society.
Derivatives may contribute to financial contagion because of the:
centrally cleared nature of OTC derivatives.
associated significant costs and high capital requirements.
reliance by derivatives speculators on large amounts of leverage.
The complex nature of derivatives has led to:
reliable financial models of derivatives markets.
widespread trust in applying scientific principles to derivatives.
financial industry employment of mathematicians and physicists.
Which of the following is
most likely
to be a destabilizing consequence of speculation using derivatives?
Increased defaults by speculators and creditors
Market price swings resulting from arbitrage activities
The creation of trading strategies that result in asymmetric performance
The law of one price is
best
described as:
the true fundamental value of an asset.
earning a risk-free profit without committing any capital.
two assets that will produce the same cash flows in the future must sell for equivalent prices.
Arbitrage opportunities exist when:
two identical assets or derivatives sell for different prices.
combinations of the underlying asset and a derivative earn the risk-free rate.
arbitrageurs simultaneously buy takeover targets and sell takeover acquirers.
For questions 46–49, consider a call option selling for $4 in which the exercise price is $50
Determine the value at expiration and the profit for a
buyer
if the price of the underlying at expiration is $55.
$5
$1
−$1
Determine the value at expiration and the profit for a
buyer
if the price of the underlying at expiration is $48.
−$4
$0
$2
Determine the value at expiration and the profit for a
seller
if the price of the underling at expiration is $49.
$4
$0
−$1
Determine the value at expiration and the profit for a
seller
if the price of the underling at expiration is $52.
−$2
$5
$2
For questions 50–52, consider the following scenario
Suppose you believe that the price of a particular underlying, currently selling at $99, is going to increase substantially in the next six months. You decide to purchase a call option expiring in six months on this underlying. The call option has an exercise price of $105 and sells for $7.
Determine the profit if the price of the underlying six months from now is $99.
$6
$0
−$7
Determine the profit if the price of the underlying six months from now is $112.
$7
$0
−$3
Determine the profit if the price of the underlying six months from now is $115.
$0
$3
−$3
For questions 53–55, consider the following scenario
Suppose you believe that the price of a particular underlying, currently selling at $99, is going to decrease substantially in the next six months. You decide to purchase a put option expiring in six months on this underlying. The put option has an exercise price of $95 and sells for $5.
Determine the profit for you if the price of the underlying six months from now is $100.
$0
$5
−$5
Determine the profit for you if the price of the underlying six months from now is $95.
$0
$5
−$5
Determine the profit for you if the price of the underlying six months from now is $85.
$10
$5
$0
CHAPTER 2BASICS OF DERIVATIVE PRICING AND VALUATION
LEARNING OUTCOMES
The candidate should be able to:
explain how the concepts of arbitrage, replication, and risk neutrality are used in pricing derivatives;
explain the difference between value and price of forward and futures contracts;
calculate a forward price of an asset with zero, positive, or negative net cost of carry;
explain how the value and price of a forward contract are determined at expiration, during the life of the contract, and at initiation;
describe monetary and nonmonetary benefits and costs associated with holding the underlying asset and explain how they affect the value and price of a forward contract;
define a forward rate agreement and describe its uses;
explain why forward and futures prices differ;
explain how swap contracts are similar to but different from a series of forward contracts;
explain the difference between value and price of swaps;
explain the exercise value, time value, and moneyness of an option;
identify the factors that determine the value of an option and explain how each factor affects the value of an option;
explain put–call parity for European options;
explain put–call–forward parity for European options;
explain how the value of an option is determined using a one-period binomial model;
explain under which circumstances the values of European and American options differ.
SUMMARY OVERVIEW
This reading on derivative pricing provides a foundation for understanding how derivatives are valued and traded. Key points include the following:
The price of the underlying asset is equal to the expected future price discounted at the risk-free rate, plus a risk premium, plus the present value of any benefits, minus the present value of any costs associated with holding the asset.
An arbitrage opportunity occurs when two identical assets or combinations of assets sell at different prices, leading to the possibility of buying the cheaper asset and selling the more expensive asset to produce a risk-free return without investing any capital.
In well-functioning markets, arbitrage opportunities are quickly exploited, and the resulting increased buying of underpriced assets and increased selling of overpriced assets returns prices to equivalence.
Derivatives are priced by creating a risk-free combination of the underlying and a derivative, leading to a unique derivative price that eliminates any possibility of arbitrage.
Derivative pricing through arbitrage precludes any need for determining risk premiums or the risk aversion of the party trading the option and is referred to as risk-neutral pricing.
The value of a forward contract at expiration is the value of the asset minus the forward price.
The value of a forward contract prior to expiration is the value of the asset minus the present value of the forward price.
The forward price, established when the contract is initiated, is the price agreed to by the two parties that produces a zero value at the start.
Costs incurred and benefits received by holding the underlying affect the forward price by raising and lowering it, respectively.
Futures prices can differ from forward prices because of the effect of interest rates on the interim cash flows from the daily settlement.
Swaps can be priced as an implicit series of off-market forward contracts, whereby each contract is priced the same, resulting in some contracts being positively valued and some negatively valued but with their combined value equaling zero.
At expiration, a European call or put is worth its exercise value, which for calls is the greater of zero or the underlying price minus the exercise price and for puts is the greater of zero and the exercise price minus the underlying price.
European calls and puts are affected by the value of the underlying, the exercise price, the risk-free rate, the time to expiration, the volatility of the underlying, and any costs incurred or benefits received while holding the underlying.
Option values experience time value decay, which is the loss in value due to the passage of time and the approach of expiration, plus the moneyness and the volatility.
The minimum value of a European call is the maximum of zero and the underlying price minus the present value of the exercise price.
The minimum value of a European put is the maximum of zero and the present value of the exercise price minus the price of the underlying.
European put and call prices are related through put–call parity, which specifies that the put price plus the price of the underlying equals the call price plus the present value of the exercise price.
European put and call prices are related through put–call–forward parity, which shows that the put price plus the value of a risk-free bond with face value equal to the forward price equals the call price plus the value of a risk-free bond with face value equal to the exercise price.
The values of European options can be obtained using the binomial model, which specifies two possible prices of the asset one period later and enables the construction of a risk-free hedge consisting of the option and the underlying.
American call prices can differ from European call prices only if there are cash flows on the underlying, such as dividends or interest; these cash flows are the only reason for early exercise of a call.
American put prices can differ from European put prices, because the right to exercise early always has value for a put, which is because of a lower limit on the value of the underlying.
PROBLEMS
For a risk-averse investor, the price of a risky asset, assuming no additional costs and benefits of holding the asset, is:
unrelated to the risk-free rate.
directly related to its level of risk.
inversely related to its level of risk.
An arbitrage opportunity is
least likely
to be exploited when:
one position is illiquid.
the price differential between assets is large.
the investor can execute a transaction in large volumes.
An arbitrageur will
most likely
execute a trade when:
transaction costs are low.
costs of short-selling are high.
prices are consistent with the law of one price.
An arbitrage transaction generates a net inflow of funds:
throughout the holding period.
at the end of the holding period.
at the start of the holding period.
Which of the following combinations replicates a long derivative position?
A short derivative and a long asset
A long asset and a short risk-free bond
A short derivative and a short risk-free bond
Most derivatives are priced by:
assuming that the market offers arbitrage opportunities.
discounting the expected payoff of the derivative at the risk-free rate.
applying a risk premium to the expected payoff of the derivative and its risk.
The price of a forward contract:
is the amount paid at initiation.
is the amount paid at expiration.
fluctuates over the term of the contract.
Assume an asset pays no dividends or interest, and also assume that the asset does not yield any non-financial benefits or incur any carrying cost. At initiation, the price of a forward contract on that asset is:
lower than the value of the contract.
equal to the value of the contract.
greater than the value of the contract.
With respect to a forward contract, as market conditions change:
only the price fluctuates.
only the value fluctuates.
both the price and the value fluctuate.
The value of a forward contract at expiration is:
positive to the long party if the spot price is higher than the forward price.
negative to the short party if the forward price is higher than the spot price.
positive to the short party if the spot price is higher than the forward price.
At the initiation of a forward contract on an asset that neither receives benefits nor incurs carrying costs during the term of the contract, the forward price is equal to the:
spot price.
future value of the spot price.
present value of the spot price.
Stocks BWQ and ZER are each currently priced at $100 per share. Over the next year, stock BWQ is expected to generate significant benefits whereas stock ZER is not expected to generate any benefits. There are no carrying costs associated with holding either stock over the next year. Compared with ZER, the one-year forward price of BWQ is
most likely
:
lower.
the same.
higher.
If the net cost of carry of an asset is positive, then the price of a forward contract on that asset is
most likely
:
lower than if the net cost of carry was zero.
the same as if the net cost of carry was zero.
higher than if the net cost of carry was zero.
If the present value of storage costs exceeds the present value of its convenience yield, then the commodity’s forward price is
most likely
:
less than the spot price compounded at the risk-free rate.
the same as the spot price compounded at the risk-free rate.
higher than the spot price compounded at the risk-free rate.
Which of the following factors
most likely
explains why the spot price of a commodity in short supply can be greater than its forward price?
Opportunity cost
Lack of dividends
Convenience yield
When interest rates are constant, futures prices are
most likely
:
less than forward prices.
equal to forward prices.
greater than forward prices.
In contrast to a forward contract, a futures contract:
trades over-the-counter.
is initiated at a zero value.
is marked-to-market daily.
To the holder of a long position, it is more desirable to own a forward contract than a futures contract when interest rates and futures prices are:
negatively correlated.
uncorrelated.
positively correlated.
The value of a swap typically:
is non-zero at initiation.
is obtained through replication.
does not fluctuate over the life of the contract.
The price of a swap typically:
is zero at initiation.
fluctuates over the life of the contract.
is obtained through a process of replication.
The value of a swap is equal to the present value of the:
fixed payments from the swap.
net cash flow payments from the swap.
underlying at the end of the contract.
If no cash is initially exchanged, a swap is comparable to a series of forward contracts when:
the swap payments are variable.
the combined value of all the forward contracts is zero.
all the forward contracts have the same agreed-on price.
For a swap in which a series of fixed payments is exchanged for a series of floating payments, the parties to the transaction:
designate the value of the underlying at contract initiation.
value the underlying solely on the basis of its market value at the end of the swap.
value the underlying sequentially at the time of each payment to determine the floating payment.
A European call option and a European put option are written on the same underlying, and both options have the same expiration date and exercise price. At expiration, it is possible that both options will have:
negative values.
the same value.
positive values.
At expiration, a European put option will be valuable if the exercise price is:
less than the underlying price.
equal to the underlying price.
greater than the underlying price.
The value of a European call option at expiration is the greater of zero or the:
value of the underlying.
value of the underlying minus the exercise price.
exercise price minus the value of the underlying.
For a European call option with two months until expiration, if the spot price is below the exercise price, the call option will
most likely
have:
zero time value.
positive time value.
positive exercise value.
When the price of the underlying is below the exercise price, a put option is:
in-the-money.
at-the-money.
out-of-the-money.
If the risk-free rate increases, the value of an in-the-money European put option will
most likely
:
decrease.
remain the same.
increase.
The value of a European call option is inversely related to the:
exercise price.
time to expiration.
volatility of the underlying.
The table below shows three European call options on the same underlying:
Time to Expiration
Exercise Price
Option 1
3 months
$100
Option 2
6 months
$100
Option 3
6 months
$105
The option with the highest value is most likely:
Option 1.
Option 2.
Option 3.
The value of a European put option can be either directly or inversely related to the:
exercise price.
time to expiration.
volatility of the underlying.
Prior to expiration, the lowest value of a European put option is the greater of zero or the:
exercise price minus the value of the underlying.
present value of the exercise price minus the value of the underlying.
value of the underlying minus the present value of the exercise price.
A European put option on a dividend-paying stock is
most likely
to increase if there is an increase in:
carrying costs.
the risk-free rate.
dividend payments.
Based on put–call parity, a trader who combines a long asset, a long put, and a short call will create a synthetic:
long bond.
fiduciary call.
protective put.
Which of the following transactions is the equivalent of a synthetic long call position?
Long asset, long put, short call
Long asset, long put, short bond
Short asset, long call, long bond
Which of the following is
least likely
to be required by the binomial option pricing model?
Spot price
Two possible prices one period later
Actual probabilities of the up and down moves
To determine the price of an option today, the binomial model requires:
selling one put and buying one offsetting call.
buying one unit of the underlying and selling one matching call.
using the risk-free rate to determine the required number of units of the underlying.
Assume a call option’s strike price is initially equal to the price of its underlying asset. Based on the binomial model, if the volatility of the underlying decreases, the lower of the two potential payoff values of the hedge portfolio:
decreases.
remains the same.
increases.
Based on the binomial model, an increase in the actual probability of an upward move in the underlying will result in the option price:
decreasing.
remaining the same.
increasing.
If a call option is priced higher than the binomial model predicts, investors can earn a return in excess of the risk-free rate by:
investing at the risk-free rate, selling a call, and selling the underlying.
borrowing at the risk-free rate, buying a call, and buying the underlying.
borrowing at the risk-free rate, selling a call, and buying the underlying.
An at-the-money American call option on a stock that pays no dividends has three months remaining until expiration. The market value of the option will
most likely
be:
less than its exercise value.
equal to its exercise value.
greater than its exercise value.
At expiration, American call options are worth:
less than European call options.
the same as European call options.
more than European call options.
Which of the following circumstances will
most likely
affect the value of an American call option relative to a European call option?
Dividends are declared
Expiration date occurs
The risk-free rate changes
Combining a protective put with a forward contract generates equivalent outcomes at expiration to those of a:
fiduciary call.
long call combined with a short asset.
forward contract combined with a risk-free bond.
Holding an asset and buying a put on that asset is equivalent to:
initiating a fiduciary call.
buying a risk-free zero-coupon bond and selling a call option.
selling a risk-free zero-coupon bond and buying a call option.
If an underlying asset’s price is less than a related option’s strike price at expiration, a protective put position on that asset versus a fiduciary call position has a value that is:
lower.
the same.
higher.
Based on put–call parity, which of the following combinations results in a synthetic long asset position?
A long call, a short put, and a long bond
A short call, a long put, and a short bond
A long call, a short asset, and a long bond
For a holder of a European option, put–call–forward parity is based on the assumption that:
no arbitrage is possible within the spot, forward, and option markets.
the value of a European put at expiration is the greater of zero or the underlying value minus the exercise price.
the value of a European call at expiration is the greater of zero or the exercise price minus the value of the underlying.
Under put–call–forward parity, which of the following transactions is risk free?
Short call, long put, long forward contract, long risk-free bond
Long call, short put, long forward contract, short risk-free bond
Long call, long put, short forward contract, short risk-free bond
CHAPTER 3PRICING AND VALUATION OF FORWARD COMMITMENTS
LEARNING OUTCOMES
The candidate should be able to:
describe the carry arbitrage model without underlying cashflows and with underlying cashflows;
describe how equity forwards and futures are priced, and calculate and interpret their no-arbitrage value;
describe how interest rate forwards and futures are priced, and calculate and interpret their no-arbitrage value;
describe how fixed-income forwards and futures are priced, and calculate and interpret their no-arbitrage value;
describe how interest rate swaps are priced, and calculate and interpret their no-arbitrage value;
describe how currency swaps are priced, and calculate and interpret their no-arbitrage value;
describe how equity swaps are priced, and calculate and interpret their no-arbitrage value.
SUMMARY OVERVIEW
This reading on forward commitment pricing and valuation provides a foundation for understanding how forwards, futures, and swaps are both priced and valued.
Key points include the following:
The arbitrageur would rather have more money than less and abides by two fundamental rules: Do not use your own money, and do not take any price risk.
The no-arbitrage approach is used for the pricing and valuation of forward commitments and is built on the key concept of the law of one price, which states that if two investments have the same future cash flows, regardless of what happens in the future, these two investments should have the same current price.
Throughout this reading, the following key assumptions are made:
Replicating and offsetting instruments are identifiable and investable.
Market frictions are nil.
Short selling is allowed with full use of proceeds.
Borrowing and lending are available at a known risk-free rate.
Carry arbitrage models used for forward commitment pricing and valuation are based on the no-arbitrage approach.
